4.3 - Globalisation and international competitiveness

Global links and their causes

Globalisation is the increasing integration and interdependence of economies. Trade is one channel; cross-border investment, finance, technology, information and labour movement are others. A firm can serve a foreign market through exports or through foreign direct investment (FDI): investment establishing a lasting ownership interest and influence in a foreign business. Buying imported goods and buying a foreign factory are distinct transactions.

Lower transport costs, containerisation and better communications reduce the cost of coordinating production over long distances. Digital delivery allows some services to cross borders without moving a physical product. Trade liberalisation reduces tariffs and other barriers, while deregulation can make foreign investment easier. A multinational enterprise can locate stages of its value chain where skills, resources, suppliers or market access suit them best.

These causes reinforce one another. Reliable communications make distant production feasible; lower trade barriers make transporting the resulting components cheaper; investment builds the factories and supplier links. But integration is uneven. Poor infrastructure, financing, unreliable institutions and difficulty meeting standards can exclude firms from international networks. Policy restrictions, security concerns or supply disruptions can reverse particular links, even if other links expand.

Their relative importance differs by activity. Lower shipping costs may be crucial for bulky manufactured goods but contribute little to a remotely delivered design service, where communications and skilled workers matter more. Where a tariff is already low, further cuts may achieve less than reliable ports or finance; where a prohibitive barrier remains, better transport alone cannot unlock sales. A claim that one cause explains all globalisation therefore needs evidence about the actual constraint, sector and period.

An illustrative company designs equipment in Country A, makes components in B and assembles them in C before selling in A. Each economy contributes value and receives income, but C's gross export value includes imported components. The location with the largest recorded gross export need not receive the largest income gain. Ask which activities, wages, tax receipts and profits stay locally.

Price and non-price competitiveness

Price competitiveness concerns prices relative to foreign rivals, measured in a common currency. Production costs, productivity, exchange rates and firms' margins affect these prices. Non-price competitiveness concerns quality, design, innovation, reputation, delivery and after-sales service. A higher-priced product can still sell successfully if buyers value these features.

Unit labour cost is labour compensation divided by output. In an illustrative factory, £120 of labour cost producing 20 units gives £6 per unit. A rival with £80 producing 10 units has £8 per unit. The higher total wage bill does not prevent the first factory having the lower unit labour cost. Productivity improvements can therefore offset wage rises. Other costs, including energy, capital and imported inputs, also matter.

An appreciation can raise the foreign-currency price of exports if domestic prices are unchanged, weakening price competitiveness. But it can make imported equipment and materials cheaper, partly offsetting the cost pressure. A depreciation can improve export prices while raising input costs and inflation. Sustained competitiveness is therefore not simply a matter of making the currency weaker or keeping wages low.

Education, infrastructure, research, efficient competition and dependable institutions can increase productivity or product quality. These take time and resources, and their effectiveness depends on what constrains firms. If delivery delays are the main obstacle, an advertising subsidy may achieve less than port improvements. Comparative advantage explains relative resource costs; the prices and characteristics buyers actually face determine sales.

Terms of trade and purchasing power

The terms of trade measure export prices relative to import prices. Using price indices with compatible coverage and base periods:

If both indices are 100 in the base year, the terms of trade are 100. If export prices later have index 120 and import prices 110, the terms of trade are $120\div110\times100\approx109.1$. This is an improvement of approximately 9.1% from the base: a given quantity of exports can purchase more imports, holding the composition of trade constant. It does not mean exports are £109.10 or have increased in volume by 9.1%.

If the index rises from 109.1 to 114.5, the percentage improvement between those dates is approximately $(114.5-109.1)\div109.1\times100=4.95\%$, not 5.4%. The 5.4 difference is index points. Use unrounded original values when available.

An improvement can result from higher export prices or lower import prices. Cheaper imported energy can improve purchasing power and reduce production costs. Higher export prices may reflect stronger demand or better quality, but if they reflect higher domestic costs they can damage price competitiveness and lower export volumes. A deterioration caused by cheaper exports may raise volumes. Thus terms-of-trade movements do not alone establish the trade balance or welfare: quantities, the cause, demand elasticities and income distribution also matter.

A commodity-dependent exporter can experience a deterioration if commodity export prices fall relative to the machinery it imports. It then needs to sell more exports to buy the same imports. Diversification or adding value may reduce this vulnerability, but technology, skills and financing can constrain adjustment.

Marshall–Lerner and the J-curve

A depreciation changes export and import prices, but expenditure is price multiplied by quantity. It therefore need not improve the trade balance, the value of exports minus imports. The Marshall–Lerner condition states that, in the standard model with initially balanced trade, full price transmission and sufficiently responsive supply, depreciation improves the trade balance when the sum of the absolute price elasticities of demand for exports and imports exceeds one.